India’s retail reforms – a boon or bane?


Background

India is looking to reform foreign direct investment in the retail sector. The major liberalisation changes announced last week could see the arrival of large, multi-brand international supermarkets like US’ Walmart, Britain’s Tesco and France’s Carrefour, in India. This potentially opens up India’s estimated US$500 billion retail market to international chains and allows easier access to India’s growing affluent middle class.

However, lawmakers, interestingly from both the ruling AND opposition parties, have strongly resisted the plans for reform and liberalization. Regional leaders of some of India’s most populous states – Uttar Pradesh, Bihar, West Bengal and Tamil Nadu – have said they oppose any plan to allow in supermarket giants. As foreign retailers each have to obtain a license from individual states to operate there, resistance by state governments means that the reforms may potentially be scuppered in major parts of the country.

The proponents of this reform, including Kaushik Basu, one of Prime Minister Manmohan Singh’s advisers have decided to intimidate the people through scaremongering and claiming that that hundreds of millions of the poorest people in India will have to pay more for staple foods like rice and vegetables if foreign supermarkets are refused permission to open. It is claimed that foreign supermarkets will help India deal with food inflation (which is in its double digits). The proponents of this reform (particularly from the government) also correctly argue that India currently lacks infrastructure, logistics know-how, good roads and transportation and lack of wholesale refrigeration and this means that there exists within the system plenty of wastage and inefficiencies. It is felt that foreign investment in the retail sector will serve to mitigate these issues and help keep food prices down and support economic activity.

The vociferous opponents to proposed reforms, which include trade unions, local government, small traders and enterprises, small farmers, argue that if the reforms were to go ahead, small businesses will be hit hard and it will also have a strong impact of small farmers who will lose even further bargaining rights subsequently. They argue that small farmers will be forced to sell out their land holdings to large corporate as they will be unable to compete with the financial might of the retail megastores.

The Indian government’s concessions

The government has faced significant opposition to their plans and has outlined a series of measures to ensure that the potential negative consequences of the reforms are mitigated. They include:

  • The Commerce Minister, Anand Sharma claims that there is a provision for procurement of 30 per cent goods from small and medium enterprises required under the new policy allowing FDI in the Indian retail sector. The ministry’s statement reads: “sourcing of a minimum of 30 per cent from Indian micro and small industry having capital investment of not more than $ 1 million has been made mandatory.” The statement goes on to add that, “This will provide the scales to encourage domestic value addition and manufacturing, thereby creating a multiplier effect for employment, technology upgradation and income generation.”
  • The policy mandates a minimum investment $100 million with at least half the amount to be invested in infrastructure developments such as cold storage and packaging, which is expected to reduce the post-harvest losses (estimated to be about 40% of total harvest annually).
  • Sharma also argues that the FDI will create up to 10 million jobs for Indians over a three year period, particularly in the supply chain management space.

My views and concerns

I agree that India needs to overhaul its infrastructure, improve roads and transportation links, increase cold warehousing facilities across the country and reduce wastage of agricultural produce in particular. These have been deep seated problems but widespread liberalization in itself is not a panacea to these deeper issues.

India cannot turn away the expertise, skills and know-how that the foreign retailing giants like Walmart, Tesco, Carrefour can bring into the country. India does not have these skill sets, we need the expertise in supply chain management and we need the investment and professionalism that these firms can bring.

However, I do have some concerns:

  • How will the interests of small retailers, businessmen and farmers be protected?
  • What guarantee do we have that these supermarket giants will simply be conduits for low-cost Chinese goods into India, further exacerbating India’s trade deficit with China (which currently stands at over US$18 billion).
  • How effective will the technical know-how, expertise and infrastructure transfer be from the international supermarkets to India?
  • There’s been an in-depth study into benefits (including increased employment, improved efficiency, lower wastage, etc) – but has there been a study into the costs of this reform (including social – labour welfare; economic – particularly from the perspectives of small enterprises and farmers; political – potential worsening of trade deficits, etc)?

My proposal is as follows:

  • India needs the Walmarts and Tescos of the world – we need the know, expertise and knowledge – and India needs to embrace globalization. But there are a few caveats:
  • Part of the investments made by the international retailers must go towards university tie-ups in the areas of global retailing, supply chain management, infrastructure, etc. This will help in the transfer of knowledge to Indians.
  • The government also needs to, alongside with the reforms, address the concerns of small retailers and include provisions within the reforms or separately a series of measures designed to support small retailers – including ensuring that a minimum percentage of supplies to the international supermarkets must come from Indian SMEs and this percentage should increase over the years and this should be mandated.
  • There needs to be better protection of small farmers – and there should be further investment towards protecting their rights and interests. A panel to support small farmers at regional levels should be set up to avoid price fixing and collusion by the larger supermarkets (a charge that’s been leveled against Walmart and Carrefour in China in the past).
  • The Indian government must make commitment to also support small enterprises by improving the infrastructure and overall supply chain logistics in India.
  • There should also be a venture capital fund (with seed funding provided by the government?) to support aspiring entrepreneurs in India to also establish their own retailing businesses. India needs its own Walmart, its own Tesco.
  • The government can also consider the possibility of a higher, graduated tax/duty regime for the larger supermarkets that are looking to access the market. Some may argue that this will deter FDI – but in a world of depleting new markets and consumers (particularly affluent middle class ones) – the international supermarkets will take this to be the cost of doing business in India. Even if nobody comes into the market as a result of this – will it make India worse off? I doubt it. So it’s a chance the country should take.
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An idea: The Greek financial tragedy – a suggestion for resolution

An overview

Greece is battling to save itself from bankruptcy. It is estimated that Greece owes up to €350 billion (approximately US$465 billion). Greece’s biggest creditors are France, Germany, UK and US. Widespread tax evasion by the wealthy and elite coupled with unsustainably high public sector debt and wages have led to this current situation. A sharp downturn for the European economy has also meant that the Greek economy’s output also was not enough to service the excessive debt. As a result, there have been painful public sector cuts and tax rises – both which have not helped the ordinary man in the street.

In recent months, the IMF, the European Central Bank (ECB) and the European Commission (EC) have all been trying to get Greece to accept a package of austerity measures that have been set as preconditions for any further help/bailout support.

The Greek picture

Essentially, all of the powers that be want Greece to undertake a series of reforms that will increase taxation, reduce benefits, reduce public sector spending as part of an international rescue package that will prevent Greece from sliding into bankruptcy. Whilst this prevents default to major creditors, this will not necessarily help the Greek people. Cuts in government expenditure are the last thing a government should do in a recession – it sucks the country into a vicious spiral which will possibly not only bankrupt a country economically, but socially and spiritually as well.

So what can the Greeks do?

A possible solution

Now, we know the Greeks have a debt of about US$465 billion. That’s a lot of money to be paid back. Greece’s GDP per annum is only about US$300 billion! With a downward spiraling economy, how is Greece going to make enough to just pay back the interest on the loan, let alone pay off the entire loan quantum itself?!

Now, one thing to note is, despite the huge debt, the Greeks have the 30th largest holding of gold in reserves in the world. Greece currently holds up to 112 metric tons (MT) of gold. At the current gold price of about US$54m per MT, Greece has a total holding of about US$6 billion worth of gold.

What does this mean? Am I suggesting that the Greeks sell off all their gold and try to lower the debt? Nope. US$6 billion is a small drop in a huge well of US$465 billion debt!

My suggestion is that perhaps the Greeks should utilise this gold in a more creative manner.

But before going any further – a primer on financial derivations (‘put options’ in particular)

A stock option (which is a financial derivative which big banks use so artistically to lose not their wealth but the wealth of nations) is basically a contract between two parties in which the option buyer buys a right (but not obligation) to buy or sell 100 shares of an underlying stock at a predetermined price from/to seller at a determined date.

Options are one of the most risky investment products available (which explains why banks love them so much) with the potential to lose all your money – but there is also the opportunity of making heck of alot of money too. (With great risk comes great reward – if you’re lucky).

An option to buy a stock at a given price is known as a ‘call option’ while an option to sell a stock at a given price is known as a ‘put option’. The predetermined price agreed between both parties is known as a strike price.

So to surmise, a ‘put option’ gives the buyer the right (but not the obligation) to sell a stock at a specified price (‘strike price’) within a period of time.

Let’s assume you are a tad bearish (and you expect the stock price of a company or an index – such as the DJIA/FTSE/etc to fall) – you can take a position of ‘going long’ on the puts – which is basically another way of saying you will BUY the ‘put option’.

What does this mean in practical terms?

Let’s say Goreng plc (GOR) is currently trading at $50. You think that GOR is going to drop to about $30 in a month’s time. Since you have a bearish view of GOR, you decide to ‘go long’ on GOR ‘put options’. You go to your friendly brokerage agency and they sell you the ‘put option’ for $5 for 100 stocks of GOR (which means it costs you a total of $500) with a ‘strike price’ of $45 (which means you have the right to sell GOR for $45) in a month’s time.

In one month, let’s say, your oracular sense of pricing was right, and GOR does fall to $30. Although you don’t own any share of GOR at this time, you can still invoke your right to sell your 100 stocks of GOR for $45 even though the market price is only still $30. You can then go to the open market and buy 100 shares of GOR at $30 a pop and sell them immediately for $45. This will make you an immediate profit of $15 per stock – or $1500 for 100 stocks.

Your total profit therefore will be $1500 (profit on the sale of GOR) – $500 (price of options you paid) = $1,000.

Which means, you’ve just made $1,000 on an investment of $500. Small outlay – big return.

If on the other hand, your prediction on GOR’s price movement was as good as the Australian cricket team (i.e. rubbish), and GOR’s price did not go down, then the only thing you would have lost would be your purchase of put options for $500.

How are options priced? Options are priced in a number of ways, but one of the more common ways is a model known as the Black Scholes model – which I will not be going through in a great level of detail – particularly since I have forgotten the derivation of it since 2001 when I did my last Corporate Finance exams! But a simple Google search should come up with various calculators, etc.

Anyway this is how some of corporate history’s greatest insider traders made a lot of money illegally. They know of a piece of news that will dramatically affect the stock price negatively. But since they are in a privileged position (ie perhaps they are part of the management team), and the market does not know of the news yet, they decide to go long on put options in the hope that the downward spiraling of the stock price helps them make money – which hopefully they don’t have too much time to spend as they should be locked up way before they are escape with their ill-gotten gains.

Hope you’re with me so far…and so moving on…

A possible solution (continued)

And so, I thought of the Greek problem from a purely academic point of view and considered the following course of action (mind you I am not advocating that Greece should do this – but will be interesting to note what the reactions will be if it does)

  1. So Greece decides that it will liquidate its current gold reserves – and does so in a systematic but careful manner – so as not to arouse too much suspicion – and sells all of its gold for US$6 billion and holds it in US$.
  2. They then go to their nearest friendly (and extremely discreet brokerage firm) and decide to go long (or buy) put options on index options of some of the largest indices in the world (including Dow Jones Industrial Average – DJIA of the USA, CAC of France, DAX of Germany, FTSE of UK, SGX of Singapore, Hang Seng of Hong Kong) on very short expiry terms (of perhaps a month at most).
  3. The Greek Parliament (who will all have to be part of this enterprise) should then reconvene and make a statement to the world (and all their major creditors) that they will default on all of their loans.
  4. This will create extreme volatility in the major stock indices of the world, causing index prices and general share prices to fall precipitously. It will also lead to international outrage and condemnation of Greece.
  5. The Greek government – after a delay of about two weeks – should then quietly dispose of their put options which will be ‘in the black’ or be profitable.
  6. So how much will they make??
  7. Let’s say that Greece decides to go only with the DJIA Index Options. The Dow Jones Industrial Average index option contract has an underlying value that is equal to 1/100th of the level of the DJIA index. The Dow Jones Industrial Average index option trades under the symbol of DJX and has a contract multiplier of $100. Currently the DJIA Index stands at 11,231 which means it trades at $112.31 (11,231/100). Let’s say that the Greeks decide on 30 days (expiration) and a strike price of $111.00 (which means they have a right to sell the DJX at $111 in 30 days).
  8. This will mean that each put option will cost the Greeks approximately US$1.33 per option. Let’s assume that the Greeks invest ALL of their US$6 billion and purchase 48 million contracts (each contract is worth 100 put options). After the announcement of the news, let’s say that the DJIA matches its worst ever fall in 1987 of 20% drop. This will mean that the DJIA will fall to about 9,000 points and the DJX will therefore trade for $90. If at this point, the Greeks decide to exercise their rights and sell all of their put options or basically buy DJX for $90 and sell them on at $111 (as per their strike price), they should make about close to $100 billion. Other indices may fall even more – and the Greeks can make more money off it.
  9. Greece then says no to bailout – try and pay off the loans and move on with life.

What will happen – and can it work?

As I stated earlier, this is a purely academic exercise. I am not sure how practicable this would be in the real world.

However, if this were to happen, then it would be the first instance of the history of the world for an entire Parliament to have committed insider trading. And what is anyone going to do about it? It will shock the global financial system – but it will not necessarily cause a meltdown. It will also result in Greece being international pariahs (at least for a while), but come on, we cannot stay mad at the guys who gave us the likes of Socrates, Plato and Aristotle for too long?

It may also force the world to reconsider this bullshit notion that we can magically make money out of nothing – and force us to re-examine the way international finance is being conducted – just by machines and making money off ‘flash trading’ or basically super-fast trading done by computers with no real understanding of context.

We need a sustainable world – and this may be the trigger that forces us to rethink and retool ourselves.

And if the Greeks do pull it off – I can see them all dancing to Bob Marley/Inner Circle’s “Bad Boys”

Bad boys, bad boys whatcha gonna do whatcha gonna do?

When they come for you?Bad boys bad boys whatcha gonna do?

Whatcha gonna do whatcha gonna do when they come for you?